What History Tells About Investing in High Yield Bonds in the Face of High Rising Rates (HYG)

From Peritus Asset Management: Looking at where we were just a year ago, we have seen a notable move upward in US Treasury yields, with the 2-year yield going from 1.29% at the at the end of April 2017 and nearly doubling to the current level of 2.49%, while the 10-year was at 2.35% a year ago and is now right around the 3% level.1

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Of note, most of the move in the longer end of the curve, the 5-yr and 10-yr yields, has come in just the past six months. These rate moves have left many questioning just what that means for fixed income investors, especially those in the high yield corporate bond world.

If we look to history, that should give us some comfort as we face the potential of higher rates. In the over 30 years of data, since 1986, Treasury yields have increased (i.e., interest rates rose), in 15 of those calendar years. In all but one of those 15 years, high yield has outperformed the investment grade bond market. The long-term numbers show that over those 15 years when we have seen Treasury yields/interest rates increases, high yield had an average annual return of 12.4% (or 9.2% if you exclude the massive performance in 2009). This compares to only a 4.4% average annual return (or 3.4% excluding 2009) for investment grade bonds over the same period.2

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So the data is clear that the high yield bond market has historically not only provided investors with solid returns during years in which we see interest rates increase, but has also dramatically out performed its investment grade counterpart.

Looking at this is a different way, below we lay out the historical returns for the high yield index during periods of rising rates. Here we specifically look at how the index performed prior to and following periods when rates rose 30bps, 50bps, 70bps, and 100bps over certain periods of time.3

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So it isn’t just full year periods where we see positive returns, but this data demonstrates that we have also historically seen positive returns in the months during which interest rates are increasing and the months after those increases have occurred.

As we have noted in some of our recent writings, this historical performance does makes sense given the high yield bond market’s lower duration and the fact that high yield performance seems to be much more tied to credit quality and default rates. We generally see rates rising in the face of economic strength– which also happens to be the premise for the current argument for rates to go higher–and economic strength generally leads to stable and/or low default rates, benefiting high yield bonds.

For more on how the high yield market has historically performed during periods of rising rates and various investment strategies in the face of potentially higher rates, see our recent piece “Strategies for Investing in a Rising Rate Environment.”

1 2-year, 5-year, and 10-year US Treasury yield for the period 4/25/17 to 4/25/18. Data sourced from the U.S Treasury Department, https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield.

2 Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). Bloomberg Barclays US Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital). Covers annual, calendar year returns from January 1986 to December 2017. 5-yr Treasury data, 2008-2012 sourced from Bloomberg (US Generic Govt 5 Yr), 2013-2017 data from the Federal Reserve website.

3 Data analyzing the month end levels of the 10-yr US Treasury yield versus the monthly returns for the Bloomberg Barclays High Yield Index, looking specifically at performance for the High Yield Index during periods when the 10-year yield moved above the noted thresholds from one month end to another. Intra-month data was not analyzed. Trailing performance numbers are for the prior 6 months and 3 months before the month end in which we saw the Treasury yield cross the threshold, for the current month in which is crossed threshold and for the one, three, and six month periods after the calendar month in which Treasury yields cross the threshold. Bloomberg Barclays Capital U.S. High Yield Index covers the universe of fixed rate, noninvestment grade debt. Data sourced from Barclays and Bloomberg and covers the period of 12/31/1986 to 12/31/2017.

Although information and analysis contained herein has been obtained from sources Peritus I Asset Management, LLC believes to be reliable, its accuracy and completeness cannot be guaranteed. This report is for informational purposes only. Any recommendation made in this report may not be suitable for all investors. As with all investments, investing in high yield corporate bonds and loans and other fixed income, equity, and fund securities involves various risks and uncertainties, as well as the potential for loss. High yield bonds are lower rated bonds and involve a greater degree of risk versus investment grade bonds in return for the higher yield potential. As such, securities rated below investment grade generally entail greater credit, market, issuer, and liquidity risk than investment grade securities. Interest rate risk may also occur when interest rates rise. Past performance is not an indication or guarantee of future results. The index returns and other statistics are provided for purposes of comparison and information, however an investment cannot be made in an index.

The iShares iBoxx $ High Yid Corp Bond ETF (HYG) was unchanged in premarket trading Thursday. Year-to-date, HYG has declined -2.17%, versus a -1.37% rise in the benchmark S&P 500 index during the same period.

HYG currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #25 of 44 ETFs in the High Yield Bond ETFs category.

This article is brought to you by Peritus Asset Management.